Municipal M&A: Budget Woes May Force Cities Like Detroit, Hamtramck To Combine

As cities grapple with continuing declines in revenue, some are considering merging with other strapped localities or sharing services in a bid to cut costs.

Local officials in Michigan, Indiana, New Jersey, California and other states are considering municipal mergers, which some see as the only way to preserve services amid a historic economic downturn. Zionsville, Ind., combined with two townships last year, and political and economic pressures are pushing other communities in that direction. In California, some cities are outsourcing services to their counties. In Michigan, politicians in Detroit and neighboring Hamtramck say merging the two governments might save the dollars needed to stay afloat.

In short, struggling governments are employing a strategy familiar to corporate chiefs and Wall Street investment banks: the merger or acquisition. Just as the recession has spurred companies to pair up, the persistent economic stagnation has made some cities see municipal M&A as a tempting, if incredibly complicated, method of cutting costs while still providing services to taxpayers. Jobs can be lost when such combinations take place, and thickets of obligations have to be reorganized. But municipal experts and local politicians say M&A is some cities' best hope for fiscal survival.

"This is, I think, going to happen nationwide. Not just in Detroit suburbs or New York suburbs or Chicago suburbs, but in effect everywhere," said veteran municipal strategist Thompson Dyke, founder of the Chicago-based urban planning firm Thompson Dyke & Associates.

"They're approaching the concept of consolidating their governments reluctantly," he continued. "They don't want to do it, I don't think. But they see this as something the electorate is going to increasingly ask for."

The worst economic downturn since the Great Depression has left many governments struggling to perform the most basic of functions. Tax receipts have withered as property values have fallen and residents have cut back on spending. Pension fund assets plunged as the stock market tumbled, with many municipal pension plans now requiring outsized contributions from taxpayers. And with states desperate to fill their own budget holes, many localities have gone without crucial portions of state aid.

Awash in red ink, governments have laid off crossing guards and dismissed teachers. Others have delayed repairs to pothole-ridden streets or crumbling buildings. Still others have slashed bus service, preventing residents from accessing tens of thousands of potential jobs. And some of the nation's statistically most dangerous cities have axed sizable percentages of their police forces.

But there may be another way.

Over the course of centuries, the U.S. has developed tens of thousands of local governments, designed to be responsive to citizens' needs. There's now one local government or public school system for every 3,500 Americans, according to Census data.

But in today's economic slump, not all of these small governments can survive on their own. With politicians reluctant to raise taxes to a level commensurate with other developed countries, localities are casting about for help. Frank Shafroth, director of the State and Local Government Leadership Center at George Mason University, speculated that in the next 20 years, one in four local governments will dissolve or merge into other governments.

"It's going to have to happen, and it's going to be very, very hard," said Shafroth, who was formerly director of government relations for Arlington County, Virginia. "There's going to have to be change. The issue is who can be really creative and innovative in thinking how to make it work."

Local officials will likely look to history for guidance. In 1963, Nashville, Tennessee, merged with Davidson County. Six years later, Indianapolis, Indiana, combined with Marion County. And in 2003, Louisville, Kentucky, consolidated its government with Jefferson County's.

Consolidations are also happening on a service-by-service basis. Last summer, officials in Maywood, California, fired all municipal employees, and outsourced services to Los Angeles county. In Costa Mesa, every firefighter was issued a layoff notice last month, but nearly all of them had been offered jobs by the Orange County Fire Authority. If that deal goes through, Costa Mesa would cede control of its fire department, allowing the county to manage any future labor negotiations. The city would shed payroll costs, but it would pay the county for fire protection.

Elsewhere, officials are itching to engage in some outright governmental M&A. Mitch Daniels, the Republican governor of Indiana, has made the elimination of township government one of his priorities. Last fall, Indiana voters approved a constitutional amendment that capped local property taxes. Given that restraint, local governments might be going the way of Zionsville, which combined with its townships last year. With fiscal pressures mounting, such mergers are likely necessary for many localities' financial survival, said Matt Greller, executive director of the advocacy group Indiana Association of Cities and Towns.

Combinations might also be in the works in Michigan, where local officials are mulling over the possibility of a merger of cities. A cluster of municipalities in the Detroit area faces severe strains, and a combination could potentially bring much-needed relief, some politicians say.

Last year, Detroit and Hamtramck, an independent city located entirely within Detroit's borders, were locked in a dispute over tax revenue. A General Motors plant -- the one that produces the Chevrolet Volt -- straddles the cities' border, and the two governments agreed decades ago to share that property tax revenue. But then Detroit started withholding payments, critically weakening Hamtramck's budget, the tiny city claimed. Desperate, the city of 20,000 people attempted to enter bankruptcy.

As part of a deal struck last month, Detroit agreed to pay Hamtramck $3.2 million for the lost tax revenue, and Hamtramck agreed to pay Detroit for water and sewer charges it owed. But both cities still face myriad woes. Hamtramck, for its part, will remain solvent only for the next 10 months, estimates Bill Cooper, the city manager.

Detroit, too, faces trouble. The decline of automobile manufacturers has put thousands out of work, and an exodus of residents has left the government scrambling to fill its coffers. Whole neighborhoods of buildings are decaying. The most recent Census numbers showed Detroit's population had dropped by a fourth over the last decade.

Making matters worse, Detroit's population has officially dipped below a legal threshold, now preventing the city from collecting a tax on electricity, heat and phone lines, and forcing the government to reduce its income tax rate. Mayor Dave Bing has taken the matter up with the state, and significant portions of the city's tax collection now hinge on whether the state legislature passes certain bills. In the meantime, the city stands to lose more than $100 million this year.

Residents of Detroit and Hamtramck have talked about a possible merger for years. Last month, Michigan passed a law empowering state-appointed managers to take over the finances of troubled local governments, a scenario that local officials are striving to avoid. With budget strains mounting, local politicians now see a municipal merger as a potential way to resolve fiscal difficulties without state intervention.

Outside city hall, Detroit politicians have quietly considered the idea of combining their city with Hamtramck and Highland Park, another municipality surrounded by Detroit. Councilman Kenneth Cockrel informally proposed taking a potential combination even further, merging Detroit with the suburbs of Ecorse and River Rouge.

"It would automatically solve the population issue," Cockrel said. "But it's not like you can just go out and do an annexation next week. There's a process you've got to undertake, and, I'll admit, I'm not totally familiar with that process."

Even if a merger could solve some of Detroit's problems, Hamtramck might resist. Hamtramck residents see their city as a relatively safe haven within Detroit, which, according to an analysis of FBI data, is the nation's third most dangerous city. The police in Hamtramck pride themselves on fast, thorough service, and some officers and residents doubt that Detroit police would be able to provide the same level of protection.

What's more, a merger would likely require a reworking of payrolls, potentially resulting in layoffs. Dan McNamara, president of the local Detroit firefighters' union, wouldn't speculate about what might happen in a merger, but expressed support for the Hamtramck firefighters. The president of the Hamtramck firefighters' local didn't respond to requests for comment.

But almost certainly, some jobs would be eliminated. At the very least, Cooper, the city manager, would be out of work, he said.

"If a community can't afford to provide the services that it should provide to its citizens, then you've got to look for alternatives," Cooper said. "If that means combining communities, then that may be what has to happen."

Any combination of cities would be complicated, likely requiring the cities to hire outside consultants. Urban planners would serve the role of bankers in a corporate merger, poring over records in search of ways to maximize efficiency.

But municipal M&A presents its own set of challenges. In Milwaukee, a local think tank released a study last year examining the consequences of a potential dissolution of Milwaukee County government. A county-city merger could yield efficiencies, the Public Policy Forum's study noted, but the county's pension and health care liabilities would present a potentially major challenge.

Those benefits have to be paid, but the question is: if the government no longer exists, who will pay them? The study authors proposed a plan where the state would administer the benefits, but only the former county residents -- the taxpayers who originally were on the hook -- would be responsible for paying them.

And, of course, a merger might not succeed in strengthening a city's budget. Local governments across the nation are saddled with ballooning pension obligations, which are protected by state constitutions. Combining governments might just amount to rearranging the deck chairs.

"Talking about merging entities will start to flush out some of the cost problems that you have," said David Johnson, a partner at the Chicago-based ACM Partners, a boutique financial firm that advises municipalities. "But that's not going to move the dial nearly as much as restructuring pension obligations would."

A successful merger, moreover, would have to better provide services to residents, said veteran bankruptcy lawyer James Spiotto, who has decades of experience in municipal restructuring. That's the metric that local officials will use, he said.

"The more local you get, the more responsive the government likely will be," said Spiotto, who heads the bankruptcy division at the law firm Chapman and Cutler. If a merger doesn't provide residents with the service they're used to, he added, "it isn't going to last."